Which of the following is a significant characteristic of fractional reserve banking?

• A. Banks are required to keep only a portion of deposits as reserves.
• B. Banks must hold 100% of deposits in their vaults at all times.
• C. Banks cannot lend out any of the money deposited by customers.
• D. Banks are prohibited from earning interest on loans.

Answer: (A)

Verified step by step guidance

1. Understand the concept of fractional reserve banking: it is a banking system where banks keep only a fraction of their depositors' money as reserves and lend out the rest.
2. Identify the role of reserves: reserves are the portion of deposits that banks are required to hold and not lend out, ensuring liquidity and stability.
3. Recognize that in fractional reserve banking, banks are not required to hold 100% of deposits; instead, they hold a fraction, which allows them to create loans and expand the money supply.
4. Eliminate incorrect options by comparing them to the definition: banks do lend out money deposited by customers (contradicting the option that they cannot), and banks do earn interest on loans (contradicting the prohibition option).
5. Conclude that the significant characteristic is that banks are required to keep only a portion of deposits as reserves, enabling them to lend the remainder.